Small Business Owners Are Downright Giddy; Here's How to Profit

The nation's small businesses are the growth engine of the American economy, so it bodes well for 2017 that the people who run them haven't felt this cheerful in 12 years.

Optimism among the country's small businesses skyrocketed in December, as hopes for the economy increased following the 2016 presidential election.

The National Federation of Independent Business (NFIB) reported this week that its gauge of small business optimism spiked 7.4 points last month to 105.8, the highest since the end of 2004, from 98.4. The NFIB report was based on a survey of 619 small-business owners through Dec. 28. Most of the December improvement came from the "expectations" components of the index.

This sanguine data suggests that small-capitalization stocks are poised to break out in 2017, even as the broader markets seem set to pull back. The iShares Russell 2000 ETF (IWM)  is the best way to play the likely small-cap surge. The ETF's share price has been rising over the past year, particularly the last two months. Shares rose nearly 1% in Tuesday trading. 

Donald Trump's plans to stimulate the economy through deregulation, tax cuts and infrastructure spending are what small business owners want to hear. The share of business owners who say now is an opportune time to hire and expand is three times the average of the current eight-year expansion.

A caveat: NFIB membership is mostly Republican, so the data could be overstating the case for growth. What's more, the nation is bitterly divided. It remains to be seen whether Trump and the Republican-controlled Congress can maintain their upper hand as the inevitable political squabbling erupts this year.

Nonetheless, perception often becomes reality and this new spurt of small business optimism could become a self-fulfilling prophecy, as the nation's entrepreneurs loosen their purse strings to invest in their own companies. This dynamic, in turn, should fuel the momentum of small-cap equities.

A small capitalization stock is usually defined as sporting a valuation of between $300 million and $2 billion. For proper diversification, every portfolio should carry some exposure to small caps.

The simplest, safest way to make money on the small-cap resurgence is to buy the iShares Russell 2000 ETF, a proxy for the Russell 2000 index of small- to mid-cap stocks. Since Donald Trump's unexpected win on Nov. 8, the Russell 2000 exchange-traded fund has jumped more than 11%; the ETF gained nearly 24% for full year 2016. Those are impressive numbers, compared to the S&P 500's gains of 5.2% and 9.5%, respectively.

With net assets of $38.36 billion, the iShares Russell 2000 ETF is the most comprehensive smaller cap benchmark, with assets distributed throughout all major sectors. Top holdings include Advanced Micro Devices, Microsemi, Webster Financial, Curtiss-Wright, and Aspen Technology. The expense ratio is 0.20%, which is low compared to the category average of 0.40%.

Despite its big run up, IWM should continue beating the market as the new year gets underway.

A big plus in IWM's favor are Trump's proposed tax policies. The president-elect has promised to lower the business tax rate to 15% from 35% for corporations and 39.6% for sole proprietorships and partnerships. Russell 2000 components tend to pay higher taxes than their blue chip, large-cap counterparts, because the big boys are more adept at lowering their tax bills.

The GOP-run Congress would be only too happy to oblige Trump in his tax-cutting endeavors, as party leaders such as House Speaker Paul Ryan (R-Wis.) finally get their chance to enact the tax and policy changes that have long topped their political wish lists.

The GOP's fierce determination to repeal Obamacare also elates small company CEOs, who chafe under the law's mandates. Meanwhile, small caps would be insulated from any trade wars triggered by the protectionist Trump White House, because they derive most of their sales domestically.

With these tailwinds, small-caps should weather the economic downturn and market correction many analysts are expecting in 2017.

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John Persinos is an analyst with Investing Daily. He also covered small businesses for Inc. magazine. At the time of publication, he owned none of the stocks mentioned.

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